U.S. Economic Outlook Winter 2010

Written by Jeff Thredgold, President, Thredgold Economic Associates

The U.S. Economy
…growth has returned
The American economy finally returned to “growth mode” during 2009’s second half, fueled in part by extremely aggressive fiscal and monetary stimulus. Pent-up demand by consumers, combined with stronger global performance, also added to growth numbers. A return to positive U.S. economic growth does not imply that problems with commercial real estate, housing, and emotional financial markets are finally behind us, but it clearly helps.

The revised 2.2% inflation-adjusted annual growth pace during the third quarter was a major departure from the 6.4% real annual rate of decline during 2009’s first quarter. A slightly stronger 2.6%-3.0% real growth pace seems likely in coming quarters.

The longest, deepest, most painful, and most pervasive recession since the Great Depression has been with us since December 2007. Good Riddance!

Budget Deficits
…the record books
Financial realities tied to the Great Recession, combined with aggressive spending by both the Bush and Obama Administrations to stabilize the economy, contributed to a budget deficit of $1.4 trillion during fiscal year 2009, which ended last September 30, easily the largest on record. A similar deficit is likely this fiscal year as well.

Perhaps the greatest challenge to be addressed over the next 12-18 months is how to reduce estimated deficits averaging $1 trillion annually during the next eight years, which are simply unaffordable. The President will face rising opposition to his aggressive spending agenda by more and more members of his own party, many who fear having to defend such spending to voters in 2010 elections.

Unemployment
…more job pain
For the first time since the Great Depression, total job losses during a recession have wiped out total job gains during the prior expansion. More than seven million people have lost jobs since the recession began two years ago, with millions more shifted to part-time employment. Even more job losses are expected during the next few months, followed by a mix of good and bad employment reports as 2010 matures.

The latest 10.0% U.S. jobless rate could approach 10.5% in coming months. Unfortunately, high jobless rates will be the norm during the next few years, with hundreds of thousands of jobs in construction and manufacturing lost for good.

Inflation
…a major debate
The Consumer Price Index (CPI) rose 1.8% during the most recent 12-month period. This followed a 0.1% rise during 2008, the smallest rise since 1954. Most forecasts expect the CPI to rise roughly 2.0% to 2.5% in both 2009 and 2010.

Where we go from there is the subject of intense debate. One vocal group of economists sees a Japanese-style deflation unfolding in coming years, tied to weak residential and commercial real estate values, strong productivity gains, major slack in labor markets, and nervous consumers. The other camp sees major inflation pressures resulting from highly aggressive monetary policy and massive budget deficits.

The Federal Reserve
…how to exit
The Fed’s critical federal funds rate, now at an all-time low of 0.00%-0.25% for over a year, will likely remain at that level well into 2010. The Fed has enacted one program after another, known as “quantitative easing,” to address the near-paralysis that, at times, plagued financial markets during the past 30 months. Whether the Fed will be able to effectively reverse such steps in coming quarters without economic disruption remains unclear.

Long-Term Interest Rates
…time is now
NOW is a great time to refinance a mortgage or buy a new home or foreclosed property. Mortgage rates for conventional loans have been at or near 40-year lows in recent weeks. Mortgage finance for higher-priced homes remains spotty in too many communities. Unfortunately, one in four U.S. homeowners are now “underwater” on their mortgages…owing more than the home is worth.

The Global Economy
…solid in 2010?
The global economy returned to growth faster than expected during 2009’s final few months, led by an Asian resurgence. Renewed growth follows the first global recession since just after World War II.

China’s economic growth engine reaccelerated in recent months, following weaker performance 9-12 months ago. Powerful growth has been fueled by massive government spending and aggressive bank lending. China is making efforts to boost domestic demand within its economy, while lessening its dependence upon exports.

Japan returned to modest growth during the most recent quarter, following this nation’s most painful recession since just after World War II. Even so, ongoing economic growth prospects are limited, tied to a massive public debt, an aging (and declining) population, and millions of disillusioned consumers.

India’s economy has picked up speed in recent months after recession-induced slowing. Solid growth is likely over the next 12 months.

The European economy returned to modest growth during the most recent quarter, led by Germany. Even so, euro strength versus the dollar has led anxiety levels sky-high in export and tourism-focused sectors.

Russia struggles with an overdependence upon energy and commodity prices. Various Middle Eastern nations are trying to limit the damage from Dubai’s recent major debt challenges.

Most South American nations have seen more signs of recent economic improvement. Major oil finds off Brazil’s coast could impact global energy dynamics in coming years.

Mexico remains mired in recession, tied to declining oil revenue and hits to its critical tourism sector. Aggressive pricing in resort communities should help limit the pain during 2010. The Canadian economy seems in transition to modest growth following recession. Even so, total employment is down 320,000 from its October 2008 peak.

The Bottom Line?
The painful and lengthy U.S. recession has finally given way to a reasonable growth pace, although serious challenges remain. We also expect…unprecedented budget deficits in coming years…mixed employment news…modest inflation pressures…extremely low short-term and attractive long-term interest rates…and a steadily improving global economy.

The Dollar

One of the first critical tests a potential candidate to serve as Secretary of the U.S. Treasury must pass is the ability to say “the U.S. supports a strong dollar” with a straight face…no smirking…no snickering…no giggles. The current U.S. Treasury Secretary Tim Geithner serving under President Obama, as well as his predecessor Henry Paulson who served under George Bush, both have/had such an ability, as did most former occupants of this powerful position.

“It is very important to the United States that we have a strong dollar,” stated Geithner at a news conference recently in Singapore. “We recognize, of course, that given the very important role of the U.S. in the global economy, the important role the dollar plays in the system, that we bear a special responsibility for being a source of stability and strength for the global economy.”

All that is well and good, and as it should be stated. At the same time, however, Obama and Geithner and others in positions of authority know that reasonable weakness of the U.S. dollar, at times, is a beneficial economic development, one that is useful in helping the economy escape the brutal winds of recession.

The Benefits…

• Current moderate weakness of the American dollar versus other major global currencies, particularly versus the euro and the yen, leads prices of U.S. exports to the world to be lower when compared against other currencies…hence greater U.S. exports and stronger U.S. manufacturing performance than if the dollar was stable or strengthening

• A weaker dollar pushes U.S. import prices higher, hence we as American consumers are more apt to buy U.S.-made equivalent products (if possible), again helping the U.S. economy

• A weaker dollar makes it more expensive for Americans to visit other parts of the world on vacation (remember vacations?)…hence we find it more attractive to vacation within the U.S.

• And a weaker U.S. dollar makes it more affordable for Europeans, Asians, and many others to visit the U.S. on vacation, as well as take advantage of bargain-priced American real estate, or perhaps even shop at U.S. stores where bargains are aplenty

Yes, there are limits as to how weak the dollar “should” get in the eyes of this Administration and many of its predecessors. The national media notes that the U.S. dollar fell to a 15-month low versus other major currencies late in 2009.

The U.S. dollar was stronger during 2008’s final quarter as global anxiety about another possible Depression was sky-high. Scared money at that time went in search of the world’s strongest, most liquid (marketable) currency and securities…yes, the dollar and U.S. Treasury debt securities.

How ’bout the flipside? Given recent weakness of the U.S. dollar, how do the Europeans, the Japanese, the Canadians, etc. feel about their “strong” currencies? They are scared to death.

A strong currency leads to just the opposite of those “benefits” noted above…a more difficult time selling, for example, German manufactured goods in the American market…a greater enticement for the “locals” to travel overseas, hurting local restaurants, shopping malls, etc. It’s also more expensive for Americans to visit foreign tourist destinations, hurting hotels, restaurants, tour companies, etc. in other nations.

This is NOT to say that a weak dollar is a positive development over a longer period of time. A weak dollar can effectively shift wealth between nations.

Too Strong
We have short memories. A major concern in global currency markets just a decade ago was that the U.S. dollar was toooooo strong. U.S. manufacturers were screaming bloody murder as to how the strong dollar was limiting their ability to sell U.S.-produced goods around the world.

U.S. travel industry executives were complaining that the strong dollar was limiting the number of Europeans and Asians and South Americans, etc. who were willing to travel to “expensive” America. A global agreement at that time did help lead the dollar somewhat lower versus other major currencies.

The dollar is a commodity, like so many others. Sometimes up…and sometimes down.